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Investors are walking on egg shells. Until this week, world stock markets had enjoyed an uninterrupted six-week rally, rising by 24 per cent. The question is if Monday’s overdue correction might mark a larger retrenchment. After all, bear market rallies averaged 30 per cent or more in 1990s Japan and in 1930s US. And Tuesday’s reported fall in March UK retail prices, the first since 1960, is a reminder that deflation still lurks.

Last month, when the rally began, there was no evidence that the world economy was bottoming. Since then, the G20 summit has come and gone, details of the US bank bail-out package have been released, interbank lending rates have fallen and some banks have even reported reasonable results. Business confidence surveys have also improved, with Germany’s ZEW index hitting its highest level in two years. As for the real economy, at the turn of the year sales were falling faster than manufacturers were slashing production. This led to huge stockpiles of unsold goods. But inventories have fallen recently, suggesting that production could, in time, rise too.

This is encouraging, but ignores several factors. Sales of goods are falling as fast as output. As a result, the ratio of inventories to sales remains at, or near, record highs in the US and Japan. So that hoped-for pick-up in demand may yet prove illusory. Another problem is that the better-than-expected bank results were largely due to smaller-than- expected writedowns; the slow grind of rising bad debts has just begun.

Finally, there is the fact that this is a globally synchronised recession combined with a vicious financial bust. Comparing 122 slowdowns in rich economies since 1960, the International Monetary Fund found that such double-barrelled recessions are typically twice as long and deep as normal slowdowns, with recoveries twice as slow and half as strong. The implication is that it will be at least another year before the recession ends in the US or Europe, and a further 18 months before recovery takes hold. Not even stock markets are that forward looking.

World stock markets were choppy on Tuesday after steep falls on Monday ended a six-week rally during which the Dow Jones Industrial index fell 3.6 per cent and the FTSE Eurotop lost 1.6 per cent, among other fallers.

Since their March 9 low, world stock markets, as measured by the FTSE All World, have risen 23 per cent.

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